What does the Comparable Method help an entrepreneur to do

Read time: 4 mins

Table of Contents Show

Methods of business valuation
How to maximize your valuation
Business valuation know-how
Read next: Understanding the term sheet
8 Basics of Accounting for Entrepreneurs
1. Register Your Business
2. Open a Business Bank Account
3. Choose an Accounting Method
4. Develop a Bookkeeping Method
5. Track Your Expenses
6. Pick Your Payment Methods
7. Learn Your Tax Obligations
8. Master Financial Reporting
What are the Benefits of Accounting for Entrepreneurs?
1. Budget for Expenses
2. Improve Efficiency
3. Simplify Tax Season
4. Monitor Your Growth

When you enter into a business valuation discussion with investors, ensure you understand the key terms.
The pre-money valuation and the amount invested determine the investor’s ownership percentage following the investment.
To determine a value for an early-stage business, most VCs use two valuation methodologies: recent comparable financing, and potential value at exit.

When you enter into a business valuation discussion with investors, make sure that you understand the key terms.

The pre-money valuation and the amount invested determine the investor’s ownership percentage following the investment.
For example, if the pre-money valuation is $4 million and the investment is $1 million, then the percentage ownership is calculated as:

Equity owned by investor = Amount invested ÷ (Agreed pre-money valuation + Amount invested)

Equity percentage owned by investor = $1M/($4M + $1M) = 20%

Post-money valuation = Pre-money valuation + Amount invested

= $4M + $1M = $5M

The pre- and post-money valuations cannot be analyzed in isolation when evaluating the financial merits of a proposed valuation. You should also consider other factors—such as liquidation preferences and dividends—to determine if it truly is a good deal.

Methods of business valuation

Most traditional corporate finance valuation methodologies do not work well for early-stage companies. Discounted cash flow (DCF) is an appropriate methodology for established companies that have a history of revenues and costs. Assumptions about market growth rates, market share, gross margins and other variables can be made to generate scenarios that will establish a valuation range. These assumptions cannot be accurately approximated for an early-stage company, which makes the results questionable.

Price/earnings (P/E) multiple is not appropriate, since most early-stage businesses are losing money. Price/sales (P/S) may be used if a company has generated some sales for a few years.

Most venture capital funds (VCs) investing in early-stage companies will use two valuation methodologies to establish the price they will pay for an investment:

Recent comparable financings: The VC will identify similar companies, in sector and stage, as the investment opportunity. Several databases—including VentureSource, Venture Wire and VentureXpert —might provide information that establishes a valuation range for comparable companies. However, transactions that are more than two years old are not considered market. Although some information may not be public, many entrepreneurs and VCs know through word of mouth what the recent valuations have been for comparable companies.
Potential value at exit: VCs and other investors have a good sense of a company’s exit value. The value can be based either on recent merger and acquisition (M&A) transactions in the sector or the valuation of similar public companies. Most early-stage investors look for 10 to 20 times the return on their investment (later-stage investors tend to look for 3 to 5 times the return) within two to five years.

- For example, assume an exit valuation of $100 million and the VC owns 20% of the company at the time of the exit. The VC would earn $20 million on their investment at exit. If the VC invested $1 million into the company, they would make 20 times their investment. If the VC owned 20% for a $1 million investment, then the post-money valuation of the company at the time of the initial investment was $5 million. As you can see, investors use the post-money valuation to estimate the price an investment must command when they exit or sell the company.

Investors will use these methodologies to set a valuation range. They will have a maximum valuation based on their view of the future valuation and the perceived competitiveness for the deal, but will try to keep the price they pay closer to the lower part of the range.

How to maximize your valuation

Make a good case. Show the investor why there is huge potential exit value for your company.
Maximize the potential exit valuation by removing any doubt or obstacle that the investor perceives as limiting the upside valuation. For example, if you have gaps in your management team, then identify the people that would join the team after the funding is secured.
Do your homework. Understand the valuations of other companies at slightly later stages. Identify and understand the gaps (technical or commercial) between your business and theirs. Then, focus your company’s business plan on closing these gaps.
Find an investment competitor. If there is competition for your deal, an investor will be more likely to give you a higher valuation. However, investors may speak to each other, so do not “play that card” if the competition does not exist.

Business valuation know-how

Remember the following when going through the business valuation process with an investor:

When you are first given a valuation, ask for a higher valuation. Pushing back demonstrates that you’re confident in your business and a good negotiator. Of course, when pushing back, provide evidence and arguments as to why the valuation should be higher. According to Guy Kawasaki’sThe Art of the Start, ask for a valuation that is 25% higher than the first offer.
Take the money and get to work if the valuation is reasonable. In most cases, businesses either make more money than you dreamed or they do not work at all. Neither the valuation nor the investor’s specific percentage will significantly affect the company’s ultimate success.
Talk to your advisors, board members, consultants and other industry players to determine if the deal you’re getting reflects current valuations.
Consider taking a lower valuation from the “better” investor, if you think that one investor brings more to the table than another.

Summary: If you’re entering a business valuation discussion with investors, do your homework (e.g., understanding key terms and how VCs calculate the value for early-stage companies).

8 Basics of Accounting for Entrepreneurs

Adopting proper accounting practices when you launch your business is crucial to succeeding as an entrepreneur. You don’t need to be an accounting expert to oversee your business finances, you just need to follow these basic accounting steps for entrepreneurs:

1. Register Your Business

The first step in getting a handle on your finances as an entrepreneur is to register your business. You’ll also need to make sure you have all the necessary business licenses, which vary by industry and state. This business license guide can help you find out what you need. You can choose from a few different business models to register your business, including:

Sole Proprietorship: An unincorporated company with only one owner, sole proprietorships are a good option for entrepreneurs because the registration process is easy and affordable. As a sole proprietorship, there’s no separation between you and your business, so you can file your business taxes as part of your personal income tax return. A potential downside, however, is that you can be held personally liable for business debts.
Limited Liability Company: A LLC combines features of a sole proprietorship and a corporation, where you’re protected in the case of company debts, but you have flexibility with filing your taxes either through your personal income tax or a separate business filing.
Partnership: If you have a business partner and want to share ownership of the company, this is a good option. Each partner is required to bring something to the business, whether it’s skills, money or property. You’ll want to have a formal partnership agreement in place to outline your roles and expectations.
Corporation: Corporations are the most complex business structure and they’re expensive and time consuming to set up. A corporation is a company that is legally allowed to act as a single entity and is considered a single taxpayer. Some of the benefits of launching a corporation include lower tax rates and greater legal protections.

2. Open a Business Bank Account

Entrepreneurs need to separate their personal and business finances. If you don’t keep your finances separate, you can easily lose track of business expenses, complicate your accounting system and you could even run into legal trouble. The easiest way to keep your business finances apart is to open a business bank account. A business checking account may be all you need when you’re starting out as an entrepreneur, or you may also want to get a savings account. Before choosing a bank for your business, make sure it meets all your needs:

Compare the small business banking fees offered by different banks
Make sure there are ATMs near your office or home for convenience
Look into the transaction limits of different banking options and make sure they work for your business

3. Choose an Accounting Method

When it comes to accounting methods for entrepreneurs, you have two options to choose from. Once you choose your accounting approach, you’ll want to stay consistent with that method to make things easier when you file your taxes. The two types of accounting methods are:

Cash-Basis Accounting: Cash accounting is the more straightforward of the two methods. It involves recording revenue when you receive it and recognizing expenses when you pay them. It’s the most popular option among new entrepreneurs because of its relative simplicity.
Accrual-Basis Accounting: Under the accrual accounting method you record revenue when it’s confirmed and expenses when they’re incurred rather than when money is actually exchanged. It gives a better reflection of your business’s overall income versus expenses than the cash accounting method gives.

4. Develop a Bookkeeping Method

Next, you’ll want to make sure your books are in order by adopting a consistent bookkeeping method for your business. The bookkeeping process involves tracking all your business transactions, from the revenue you earn to the expenses you incur. You’ll need to develop a bookkeeping method that you can stick with, so that you’re able to track all the money coming into and going out of your business. Here are some options for bookkeeping methods:

DIY Bookkeeping: When you’re starting out as an entrepreneur, you might be able to get away with tracking all your business transactions using a spreadsheet. However, as your business grows, you might not have the time to manage all your bookkeeping manually.
Cloud-Based Solution: For a small fee, you can subscribe to a cloud-based accounting solution that can help you manage your bookkeeping online and can even connect to your business bank account to track transactions automatically.
Part-Time Bookkeeper: If you don’t want to worry about your bookkeeping and prefer to outsource the job to someone else, you can hire a part-time bookkeeper to manage the workload for you.
In-House Bookkeeper: If your business grows to the point where bookkeeping becomes a full-time obligation, you can opt to bring on a full-time bookkeeper in house.

5. Track Your Expenses

As an entrepreneur, you’ll need to track all your business expenses to create an organized record for tax season. It’s important that you develop a filing system for all your receipts and other paperwork, either by storing physical copies or developing a digital filing system. Some of the paperwork you’ll want to track includes:

Bank and credit card statements
Receipts from business meals, parking, travel, supplies, equipment, etc.
Office bills, including utilities, internet, phone, etc.
Financial statements
Tax returns

For a full list of the records you should file as an entrepreneur, visit the IRS website.

6. Pick Your Payment Methods

Once your business is off the ground, it’s time to get paid for your hard work. To do so, you’ll need to decide which payment methods you’ll accept from your clients. If you’re just starting out you can stick to simpler payment methods, like checks and cash. But if you offer more flexible payment options, you may find that your clients pay you faster. Here are some other options to consider:

Credit Card Payments: If you have a brick and mortar shop, you may wish to set up a point-of-sale (POS) system and accept credit and debit payments in person. You’ll have to pay transaction fees every time a customer pays with a credit card.
Mobile Payments: Mobile payment providers like Square are a great option for entrepreneurs who conduct their business outside of an office. You’ll get a mobile card reader that attaches to a smartphone and pairs with an app to accept payment from anywhere with an internet connection.
Online Payments: Online payments are a convenient payment option that many of your clients will be familiar with. You can either set up online payments through your website using a third-party provider like Stripe, or you can accept online payments directly through your cloud-based accounting software.

7. Learn Your Tax Obligations

As an entrepreneur, filing your taxes can be a bit daunting, especially if you’ve never done it before. Your tax obligations will depend on how your business is registered, since the requirements for a sole proprietorship are quite different from those of a corporation. Here are a few key tax obligations you’ll want to prepare for as an entrepreneur:

Self-Employment Tax: All self-employed workers need to pay the self-employment tax to cover your Medicare and Social Security obligations.
Employment Tax: If your business has employees, you’ll need to pay employment tax according to the Federal Insurance Contributions Act (FICA), to contribute to your employees’ Medicare and Social Security coverage.
Income Tax: The income tax you file will depend on how your business is set up. If you run a sole proprietorship, you can file your business taxes as part of your personal income taxes. If you own a corporation, you’ll need to file separate tax returns for your company.
Sales Tax: The sales tax you’ll need to charge clients and collect for the government is determined at the state level. Do your research to find out how much sales tax you need to collect and when you need to submit it to the government.

8. Master Financial Reporting

Financial reports are crucial for entrepreneurs because they track how your business is performing. They can help you make informed decisions about the future of your company and show you how to become more efficient. The major financial statements entrepreneurs should be familiar with are:

Income Statement: An income statement shows the revenue, expenses and ultimately the amount of profit or loss generated by a business, for a specific reporting period.
Balance Sheet: The balance sheet reports a business’s assets, liabilities and equity at a specific point in time. In other words, it shows what a company owns and what it owes on a single day.
Cash Flow Statement: Your cash flow statement offers a summary of the cash and cash equivalents coming into and going out of your business.

What are the Benefits of Accounting for Entrepreneurs?

As an entrepreneur, proper accounting can help you better understand your business’s financial health and make informed decisions about your company’s finances. Here are some of the main benefits of proper accounting techniques for entrepreneurs:

1. Budget for Expenses

Accounting can help entrepreneurs create and manage detailed budgets for their businesses. When you understand how much money is coming into and going out of your business, you’re better equipped to plan for your expenses.

2. Improve Efficiency

With a proper accounting system in place, entrepreneurs can forecast revenues for their businesses. You’ll be able to see how efficiently your company generates revenue from your expenses. With that information, you can evaluate your marketing efforts to invest in campaigns that drive revenue and abandon those that don’t.

3. Simplify Tax Season

Accounting helps entrepreneurs prepare for tax season, to ease the headache of filing income taxes. With proper accounting and bookkeeping, you’ll have all the records of your business’s earnings and expenses filed away, which will make filing your income tax quicker and easier.

4. Monitor Your Growth

Accounting gives you a handle on your company’s assets and liabilities and how they change over time, which lets you monitor the growth of your business. You can understand what services are driving the most revenue in your business, which can help you adjust your business model to further grow your profits.